TRUMP: DXY V EUR/USD, Yields, S&P’s

If Trump is a true William Howard Taft Capitalist / Republican in the spirit of Warren Harding, Calvin Coolidge, Herbert Hoover and Ronald Reagan and if he can overcome the Fabian Socialist tendencies of the current majority of Teddy Roosevelt Republicans / Democrats then prosperity will reign from 2016 to 2020. Many questions exist to the Trump/Taft scenario.
Trump’s economic plan not only advocates a slash of personal and corporate taxes, high GDP and pro growth scenario but the architects of the document are Taft Republicans from the Reagan administration. Most prominent names include David Malpass, Arthur Laffer and Stephen Moore. With Malpass, Moore and a pro growth agenda, economic conservatives from the Reagan era such as Larry Kudlow joined the Trump bandwagon to advocate Trump’s presidency. Advocacy for Trump is found more inside the philosophical economic agenda rather than strictly in the name of Trump.
America began as an idea, an ideal, a thought, a philosophy to represent a chosen group of people whose desire was independence as people as they fled heavy handed government. The 1912 election between Teddy Roosevelt and William Howard Taft split the independence agenda into left thinking big government as solution to political, social and economic problems by Roosevelt or Conservative small government and independent capitalism under Taft.
The small government conservatism under Thomas Jefferson merged with the Radicalism big government agenda under Andrew Jackson and formed the modern day Democratic Party. William Jennings Bryan’s 1896 Cross of Gold speech sealed the Democratic Party’s fate as permanent big government as solution. Trump and the Taft wing of the Republican Party now stand as a minority view particularly under the economic agenda.
Proposed Corporate taxes drop from 35% to 15% while individual tax brackets cut from 7 to 3 with lower tax rates to 12%, 25% and 33%. The idea is 1.2 million jobs are created for every 1% of higher GDP with an overall goal of 4% GDP and 3.6 million jobs created. Job creation assumes conglomerate US companies leave locations in Ireland and other tax friendly havens and return home as well as agree to repatriate monies to employ inside the US economy.
Since all revenue and tax bills by constitutional Article 1, Section 8 originates from the House of Representatives and a clear majority of Republicans will continue its House dominance as well as small majority in the Senate, Trump’s plan has every ability of easy passage. From an economic perspective, Trump could easily become not only a Taft Republican to lead prosperity but has every ability to switch back to Reagan’s winning Supply Side economic system from the current hocus pocus, tool box tricks of Obummer’s Keynesians.
Trump’s first hurdle is elimination of stimulus in order to allow interest rates to free float and to understand where true real and nominal rates of interest rates are located. The current yield curve is suppressed from 2 to 5 year maturities as the vast majority of stimulus bonds are reinvested from 2 to 5 years. This created a yield curve steepener from 10 to 30’s. Fed Funds Effective is purposefully held at 0.40 to allow the artificially created corridor from 10 to 20 to hold Fed funds in place.
If stimulus is rescinded, not only will yields rise but yields travel higher because economic data will materially improve as stimulus and economic data negatively correlate. Stimulus and interest rates also negatively correlate. Add lower tax rates to the equation then the US sets up to become an economic powerhouse with yields and interest rates leading the way.
The risk to the current yield curve scenario is higher GDP, lower taxes, higher interest rates must see the short end 2 to 10 year maturities rise. If short maturities lead an economic expansion then the longer 10 to 30’s generally fall. The short end rise over time threatens a flat yield curve and flat yield curves warn of recessions ahead.
The current 2 to 10 spread runs 0.88 V the 10 to 30 at 0.73. The 10 to 3 month rate runs 1.32 and just below the 20 year Natural Interest Rate at 1.64 yet 1.32 is 90 basis points higher than the 0.40 Fed Funds rate. The 10 minus 3 month typically equates to the domestic interest rate and in the caee of the US its 0.40 so 90 runs high yet overall the yield curve message is the Trump economic plan has ability to implement and run over time without recession threat.

The 2 year yield must break 1.170 to experience an upward trend . The point at 1.170 is a level last seen in monthly averages exactly 8 years ago and at the time of the 2008 crisis.

What determines direction to markets is the DXY and EUR/USD relationship as both currencies were designed as polar opposites. Currently, both DXY and EUR/USD sit together exactly on trend lines from 2 to 10 year monthly averages. The market message is not only refrain from long term positions but uncertainty is evident as to overall direction. A break will and must occur and this break informs other currency pairs, commodities, stock markets and whether markets enter risk on or risk off mode. Further, a break informs the success or failure to the next president.
Assume DXY breaks higher and EUR/USD travels lower then commodities will head lower and includes WTI because of negative correlations DXY generally shares against a vast majority of commodities. A lower DXY, higher EUR/USD imparts the message USD yields and interest rates trade lower. A higher DXY is the first sign to a vote of confidence in a Trump economic plan and overall administration. Viewed from the Hillary Keynesian perspective and increased tax rate policy, a higher DXY, interest rates and yields offers a vote of no confidence to an economic recovery.
DXY along the curve to 10 years must break lower at 95.32 then 90.70, 88.37, 86.70, 85.61, 84.41 and 84.21. Then next 83.18 nd 83.08. Overall, DXY began at the 2008 crash at 78 and 77.00. Once broken above, DXY traveled to 105.’s to current 95.00’s.
The current S &P 500 Price / Earnings Ratio is 24.59 and ranged historically to a high of 45 as an average to its historic average at 15 lows dated to the  1900’s. Overall, 24.9 is high yet it represents a fairly rangebound, non trending market and representative to the DXY V EUR/USD dilemma. What drove the S&P’s higher since 2008 was the Price in PE in a low inflation and low interest rate environment against a low PE Ratio near its 15 lows. What will drive the S& P’s in a Trump Administration is a number of factors.
Lower corporate taxes and higher GDP will send the S&P’s higher because the E as Earnings for corporations will expand to drive the P higher as well. Add higher yields and interest rates then the stage is set for higher S&P’s. The perfect example is found under Reagan in the 1980’s.
The overall question and main driver to the S&P’s historically is Inflation. Higher Inflation drives PE Ratios and S&P’s lower and the best evidence is seen in 20% Inflation rates in the 1970’s.
The overall higher or lower Inflation question in a Trump Administration should be a lower Inflation rate if stimulus is rescinded and this will drive the S&P’s higher. Higher Inflation is not worth the added premium expense factored to a stock or index price in profit return. Under Hillarious as is the term for Hillary Clinton, not an ounce of confidence exists to consider higher S &P’s due to a higher Tax plan and more of the same Keynesian policies in higher Inflation rates. Add current 24.59 PE Ratio then long S& P’s becomes a risky investment. Why 2% Inflation is because it supports the higher money supply. Further, 2% meets the bottom 10 to 20 basis point and artificial corridor inserted under the current 0.40 Fed Funds rate.

 

Brian Twomey, Inside the Currency Market, btwomey.com

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